Consider a firm with a debt-equity ratio of 0.40. The required rate of return on this firm’s unlevered equity is 18% and the pre-tax cost of debt is 8%. Sales, which totalled $34 million last year, are projected to remain at that level for the foreseeable future. Variable costs comprise 52% of sales, while fixed costs are $5,000,000. The corporate tax rate is 35% and all earnings are distributed as dividends to shareholders at the end of each year. Based on the above information, answer the following questions:
What is the value of the firm if it carried no debt?
What is the required rate of return on the firm’s levered equity?
What is the value of the company’s debt and equity using the WACC method? Use the WACC to also calculate the firm’s total value.
What is the value of the firm’s equity if the FTE method is used?